Background
Pension plan charging structures have changed and evolved over
the years. Companies have developed a variety of charges, and it is
sometimes not straightforward to work out whether these charges
apply to you because they depend on your individual
circumstances.
It is very important to be aware of the charges for your
particular pension fund so that you can make sure that you are
getting good value for your money. When making financial
decisions in connection with your pension, for example if you are
thinking about retiring early or changing your investments, you
should check whether your planned course of action will result in a
charge.
Older schemes vs newer schemes
It is often the case that older schemes have a more complex and
expensive charging structure than newer ones. However, if you
are considering a switch to a newer scheme, you should ensure that
you understand the charges of both schemes. Probably, the
easiest way to make a charge comparison is to ask your provider for
a current fund value and transfer value of your pension. This will
enable you to see what the costs are in moving away from your
current provider.
A financial adviser should automatically do this in preparing a
pension transfer analysis for you. Additionally, a financial
adviser's transfer analysis will incorporate a projection from your
pension provider to your chosen retirement age, allowing you and
your adviser to see the immediate impact of charges in a new
contract versus your old contract through to retirement.
If you would like assistance with getting financial advice,
please read the Spotlight fact sheet on this topic which is on the
'publications' area of our website.
Annual management charge
If you have a money purchase pension scheme, you will be charged
an amount each year (often a percentage of your fund) to cover the
cost of investing your money and administering your plan. This
includes occupational defined contribution pension schemes,
personal pension plans, self-invested personal pensions (SIPPs) and
stakeholder pension schemes. An annual management charge will also
apply to the new National Employment Savings Trust (NEST). The
amount of the annual management charge varies between schemes and
pension providers, so it is important to compare the annual
management charge if you are considering joining a pension
plan.
It is worth bearing in mind the following points:
- Employers can often negotiate lower annual management charges
with their provider if they have a big workforce. Therefore if you
have the chance to join your employer's scheme, you may pay a lower
charge than if you have your own personal plan.
- Charges on group personal pensions (GPPs) tend to be more
competitive than SIPPs because their funds tend to be less
specialised. However, this is not always the case.
- Charges on pension plans are often lower than other savings
products such as Individual Savings Accounts (ISAs).
- Even though you are paying charges on your pension plan, you
may be getting contributions from your employer. Therefore, think
very carefully before deciding not to join a pension offered by
your employer. In addition to building up a pension with your
employer's contributions, you also get tax relief.
The charges are not the only factor you should consider when you
start a pension. Good quality administration is also
important. Some pensions have a quality standard applied to
them. For example, the National Association of Pension Funds
awards a Pension Quality Mark to schemes that meet certain
standards.
Active member discount
Many costs within group schemes don't vary with size of member
fund and apply whether a member is active or deferred. This can
mean that those who build up larger funds from maintaining
contributions are subsidising those who do not. Some
employers don't think it's fair to expect those who stay active
within the scheme to subsidise early leavers. They want to reward,
not penalise, those who stay with them. Active member discounts
(AMDs) were introduced to address this.
AMD structures allow an employer to offer a discounted annual
management charge to employees who continue to contribute within
their workplace pension. This means that if you leave the
scheme, your annual management charge may be a higher percentage of
your fund than if you stayed in the scheme, even if you left your
employer and therefore had to leave the pension scheme for reasons
outside of your control.
The Pensions Regulator has said that it does not view active
member discounts as fair for certain members of trust-based
schemes, and it is likely that this area will be investigated
further by the Pensions Regulator in due course.
Stakeholder pension charges
A stakeholder pension differs from a personal pension plan
because it has been designed to incorporate a set of minimum
standards laid down by the government. These include:
- A charging structure that is capped at a maximum of 1.5% annual
management charge a year for the first 10 years and 1% a year
thereafter;
- There can be no penalties on altering or stopping contributions
or on transferring the benefits to another scheme
A stakeholder might therefore be a cost-effective alternative to
a personal pension - but you should obtain full details from your
chosen provider so that you are fully aware of all the charges
involved before you decide whether to go ahead.
Policy fees
Policy fees cover administration charges - as opposed to the
cost of investing your money. This is usually included within
the annual management charge, but older plans tend to have a
separate policy fee.
Bid/offer spread
This is an investment charge and refers to the difference
between the buying and selling price of a unit in a pension fund. A
typical bid-offer spread would be 5%. For example, if you invest
£100 in your pension fund, its value would become £95
(£100 less 5%) if you withdrew the money immediately. The
buying and selling price of the units in a fund depend on the value
of the assets in the fund.
Allocation rates
If you invest £100 in your pension scheme, it is not
necessarily the case that all of it will be invested in your
policy. With some (typically older) pension contracts, a
proportion of your investment is used to buy units in the
investment fund. This percentage is known as the 'allocation rate'.
As a rule of thumb, the older the pension policy, the lower this
rate will be.
For example, some old-style pension would have used only 50 per
cent of the first few years' premiums to buy units, with the rest
being retained by the insurer. However, providers came under
pressure to offer fairer terms and most allocation rates are now
closer to 100 per cent.
Fund switches
If you want to move your money from one fund to another, within
the same scheme, there may be a fee for doing this.
Sometimes, your provider will allow you to make a certain number of
switches per year before you are charged. The fee for making
a switch is sometimes a fixed amount or it can be a percentage of
your fund.
You should check your provider's literature to see what fees
apply.
Initial and accumulation units
If your pension is split between initial and accumulation units,
it is likely that your annual pension statements will list how many
of each type you hold.
Pension companies who do not use reduced allocation rates may
instead use different types of units. In the first few years of
your policy, your money will be invested in capital units which
carry higher charges. After an initial period (the exact length of
time will depend on the individual contract), your money will
instead be used to buy accumulation units, which attract lower
charges - typically one per cent a year.
Apart from the charges, there is no difference between the two
units. Rather than pay monetary bonuses, your pension provider may
give away additional accumulation units at the end of each year,
depending on how the fund has performed. Or it may reduce the
period of time in which your money is investing in capital
units.
Difference between fund and transfer values
Sometimes you may find that your fund value (the value of your
total investment in the scheme) is higher than your transfer value
(the amount available for you to transfer to another
scheme).
There can be several reasons for this.
- Bid/offer spread, as explained above.
- Sometimes if you transfer out of a defined benefit (final
salary) scheme, the transfer value might be scaled down if the
scheme is in deficit. Your scheme administrator should warn you if
this is the case.
- If you have a with-profits policy, or if your pension is
invested in with-profits funds, your fund may be subject to a
deduction called a market value adjustment (MVA) if you transfer
out. This is described below.
It is important that you consider getting financial advice if
you are considering a transfer.
Stopping contributions
Some older pension plans may apply penalties for stopping
contributions, by increasing the charges. This is designed to
collect the charges that would have been collected from future
contributions.
Market value adjustment - with-profits policies and funds
With-profits funds differ from unit-linked funds which fluctuate
in line with the underlying investments. A with-profits fund
participates in both the underlying investments and also the
profits of the investment company.
The intention of a with-profits fund is to smooth out the
investment return. Some of the profits from years of good returns
are set aside to provide bonuses in years of poor returns. In
theory the fund shouldn't go down in value, but a company may apply
an MVA. This is sometimes called a market value reduction
(MVR).
If there are large numbers of transfers out of a pension fund,
it can seriously deplete the profits set aside, and as a result an
MVA may be applied.
This is the insurance company's way of protecting the remaining
policyholders and fund by providing some compensation to those
remaining in the fund. The transfer value available to you may be
reduced if you decide to transfer out when an MVA is being applied.
This is usually expressed as a percentage of your fund and can be
as high as 10-15%.
As this can reduce your transfer value quite dramatically it is
important that you contact your pension company to see if they are
applying an MVA. It can also reduce the value of your fund if
you decide to start your pension early (before the age specified in
your policy).
Your policy may guarantee that the MVA will not be applied in
certain circumstances, for instance if you retire at the age
specified in your policy or if you die beforehand. There may be
other circumstances depending on the type of policy: please refer
to your policy literature.
